12/01/10

From Comment

Reflections on the Trust and the Future

Nigel Goodeve-Docker examines how the offshore trust has deviated from its original purpose and assesses the consequences.

The Alternative Investment Fun…

In the development of the facilities offered to individuals by the offshore world, one can see part of the cause of the current onslaught by the major Western countries on the offshore centres.

The key to this development has been the speed with which communication difficulties have been overcome to the extent that today one can as easily do business in an offshore jurisdiction as in one’s own, coupled with the desire and ability of professional businessmen, both onshore and offshore, to promote the benefits of the offshore jurisdiction.

These benefits for individuals are principally:

privacy;

security (or asset protection); and

tax reduction or avoidance

(There is no significance in the order). They are, however, not new.

Indeed, they were the main reason why one of the offshore world’s major weapons was developed by the late mediaeval Chancery lawyers in London in the 14th and 15th centuries – namely the Trust. It has been estimated that, by the end of the 15th century, 70 per cent of all land in England was owned through a Trust. It gave the privacy and asset protection needed in those troubled times, but it also deprived the Crown of the mediaeval equivalent of inheritance tax on death! Were any of those great lawyers (who practised without the aid of printers, copiers, computers, and the other toys of today) to be transplanted into the office of a legal firm offering the Trust facility, it would not take him long to recognise that this weapon is essentially the same as the device which he developed 600 years or more ago. Equally, he would recognise that the driving forces behind its use are much the same as they were in his time.

The causes for the 20th century promotion of the Trust are much the same as they were then – political instability, social upheaval and excessive taxation. Then it was the Monarch needing the money, but now it is Government. In both cases overspending was/is at the heart of the matter, but in the latter case it was part of the search for greater public support and thus of the corrosive nature of political power. Human ambitions in general rarely change except in the packaging with which they are promoted, and this applies equally to the governors and the governed.

It may be difficult today to appreciate just how strong were the fears of the Cold War through the 1960s and 1970s and beyond (building on the cataclysmic upheavals of two World Wars) and the constant uncertainty as the Communist or Totalitarian systems sought to destabilise the West. At the same time, many Western peoples were flexing their “people muscle” and demanding ever-increasing social benefits and security for the less advantaged. Social security systems absorb state finance at huge (and, ultimately, probably insatiable) levels, which have to be paid for with real money, which, it is believed, can be produced by taking money by taxation from those perceived to be able to afford it, i.e. the wealthy, and delivering it to those who “need” it, conveniently forgetting that it is usually the wealthy who produce it in the first place and can therefore move or stop producing it if they wish.

Not surprisingly, individuals faced with these governmental attacks have sought to protect themselves and their families, by adopting measures to reduce liability to excessive tax, to reduce their exposure to expropriation risks from political instability and to provide the safety of privacy in the face of increasing and intrusive means at Governments’ disposal to invade privacy with its loss of personal security.

One of these measures has been the use of the Trust. Although the Trust had been developed for these very purposes so many centuries before, its use through the 18th and 19th centuries had become confined (in the United Kingdom (UK) and its Empire extensions) to a safe and flexible method of protecting and securing succession to property (be it land or money). However, starting shortly before the First World War and increasingly in response to Government attempts to deal with its economic after-effects, UK lawyers began to use (or re-use) the Trust (as had their forebears) as a tax-planning or tax-avoidance weapon, but they pioneered a new variation. This was the use of the “discretionary” trust, the idea broadly being that no-one could be taxed on it or its funds as no-one “owned” anything. While it provided extra protection and security in those early days of the 20th century the driving force behind the development of the discretionary trust was the avoidance of perceived penal levels of taxation.

This set off a new game of taxation ping-pong, as Governments tried to stem perceived tax loss through anti-avoidance measures, only to be confronted by lawyers and accountants devising ways around those measures etc. It will not be surprising, however, to learn that this was precisely the battle fought over the Trust between Monarchs and lawyers centuries ago, culminating in Henry VIII’s attempt to crush the Trust once and for all in 1535 by legislating it out of legal existence. This would have succeeded but for a combination of brilliant lawyers, sympathetic judges and (eventually) changing social conditions, so that the Trust reappeared (changing its name from “Use” to “Trust”) in the 18th century as a means of controlling inheritance and the power which comes from the use of such wealth. Professionals and institutions involved in using the Trust today should pay homage to these remarkable men.

Then through the 1950s and into the 1960s, and led by the UK with rates of income tax rising to 98 per cent or even worse, advisers (finding domestic tax systems increasingly difficult to crack) turned to the offshore world as “new ground” and, where the client demand went, so too did the financial institutions and the professionals to provide the facilities. (The story of the Cayman Islands and its special legislative “treatment” of discretionary trusts, as formulated by Milton Grundy, is now legendary in the history of the offshore world).

The success of the discretionary Trust spread to offshore centres, and with it came the hard promotion, as Trusts brought with them considerable fees for lawyers, bankers, accountants and others from their creation and administration. But now what used to be done quietly and confidentially was increasingly being advertised widely as a tax avoidance and asset protection tool for individuals, in many cases claiming to provide benefits which did not really fit in with Trusts as such. It was one thing for trusted family advisers to be trustees of a family “discretionary” Trust, but quite another when the Trustee was a person unacquainted with and even unknown to the person creating the Trust (the settlor) and interested only in providing these services because he or it made a (lawful) profit out of them.

Matters became even worse when the client was told (as so often he was – whatever the “file” might show!) that he did not need to worry about the apparent legal width of the discretion held by this unknown person, because (privately) he could control the situation through Letters of Wishes and then through a new person called a Protector and similar devices.

By now, the Trust was being exploited and over-promoted, often by persons who knew little about Trusts (and, sadly, cared less) but thought of them as no more than a commercial or investment tool for the promoters, and exploitable as such – with little heed for the consequences.

Moreover, Trusts were being increasingly “sold” as a marketing product to persons such as those newly arriving with (sometimes murky) wealth from “new” parts of the world where the Trust was unknown e.g. the former Communist States), and in other cases from countries where the Trust was (or might be regarded as) contrary to their culture. I doubt whether at most more than a handful of them understood even broadly what was this Trust thing which they were creating, and most would probably have failed even to read the overly lengthy document, couched as it was in a foreign language overlaid with archaic legal verbiage. Why read something which you did not understand but which anyway your advisers said (off the record) achieved what you wanted through your control with a Trustee who would do as you told him?

It is principally for this reason that what was once a beautiful, useful and sensible creature of the English legal system has become almost a bastardised caricature of its former self. (My comments are directed solely to the private trust, not the use of “public” trust structures for public investment purposes such as unit trusts and similar public funds).

It is unsurprising, therefore, that not just States where the Trust is an alien incomprehensible creature (such as the Civil Law countries of Europe and those jurisdictions derived from them) but even those States where the Trust has been part of the legal (and social) tradition for centuries have joined hands to condemn the Trust as a tool of illegality and to wage war on those offshore centres which promote it for the use invariably of those from outside their borders. If you tweak the dragon’s tail too often and (worse) too publicly, you cannot complain at a violent reaction, and it is just bad luck that it has coincided with the failure of many Western Governments (and beyond) to manage their economies responsibly, which in turn in the instinctive reaction of failing Governments, has led them to try to divert the public gaze with headline-grabbing graphic attacks on “tax havens” and “tax abusive systems”, blithely ignoring that those countries would not have achieved their position but for the very failings of the attackers. But such is life!

The heyday of the Trust (particularly in its generalised offshore “form”) is probably over. Clients and practitioners face great hostility from those with power. That much of this hostility is misplaced and based on misunderstanding is sadly irrelevant. The attack once made cannot be withdrawn. Like a dragonfly, the genie of the Trust may have flown and be disappearing. Nor does it help that the latent distrust and hostility of States which “know not” the Trust have been stoked by the leaders of those States which do “know” the Trust and therefore should know better but choose to distort the truth for political ends. Sadly they are not over-concerned at throwing out this baby with the bath water. The UK’s manipulative Prime Minister is a prime example.

If this sounds pessimistic, it is not intended to be. Rather it is intended to inject a note of realism. Perhaps we shall see over this century what they saw over the 18th and 19th centuries, namely that the private use of the Trust will revert back to what in truth it is best suited – the proper achievement of a secure inheritance and principally for those who either through tradition live easily with the concept of a Trust or take the trouble to master its essentials through their advisers and where it can achieve properly their objectives, remembering that it is not a cure-all but an instrument, albeit of great use, with limitations. In addition, there will always be sound proper reasons for using at times a Trust outside one’s jurisdiction, particularly as people become more mobile.

Looked at in this light, those who perhaps might have been better advised anyway to look beyond a Trust may find the answers to their particular problems in other structures, perhaps of a corporate or quasi-corporate nature. In this context, it is fascinating to see the rise of the Foundation (which is a creature solely of the Civil Law system), or more accurately its availability, through local statute, outside Civil Law countries. There may be few from non-Civil Law countries who will be attracted for legitimate reasons to what is an alien structure with alien legal concepts, but it will be interesting to see whether those from Civil Law countries, to whom the Foundation is as traditional as the Trust is alien, will have the necessary confidence that the backing legal systems of non-Civil Law jurisdictions (where the judges and the lawyers will have the same difficulties in reverse) can make Foundations there as attractive as Foundations in countries where they are as familiar to their judges and lawyers as Trusts are to those in Common Law countries. The danger is that legal concepts and approaches may spill over into, and influence, an area where juridically they have no proper place. Hence new challenges and new interests!